It is helpful, from time to time, to step back and look at the bigger picture regarding expected asset returns over the longer run. Gavyn Davies, Chairman of Fulcrum Asset Management, wrote an interesting column in the FT blog recently which provides insights into the factors which are likely to drive equity returns over the long run. To summarise:

-Over recent decades, Thomas Piketty has shown that the wealth/income ratio has increased rapidly, in contrast to a stable equilibrium level which has prevailed over the very long run.

-Two factors have primarily driven this phenomenon – a long term decline in global real interest rates and the continuous rise in the share of profits in national income, resulting in rising expectations of future profits being discounted at lower interest rates resulting in higher equity prices. In addition, declining inflation has also helped support both equity and bond prices (see graph below).

-In a recent paper, Goodhart and Erfuth have suggested that the above factors have resulted from a long term decline in the ability of labour to maintain growth in real wages in line with productivity. Unless this trend is reversed, the trend is rising asset prices is likely to remain intact.

-While the falling share of wages in national income would naturally result in a rising share of profits in GDP and therefore support higher equity prices, why has this caused the long term decline in real rates?

-This can be explained by declining real wages causing rising inequality with the shifting of wealth and income from the poor to the rich, thereby lowering aggregate demand in the economy as the poor have a greater propensity to consume than the rich.

-Governments have tried to support demand via fiscal policy (reducing taxes and increasing subsidies to the poor) but given the constraints on increasing the debt/GDP ratio, the onus has increasingly fallen on central banks to use monetary policy to lower interest rates and boost demand. However, this has caused asset prices to rise even further and increase inequality even more.

-This negative feedback loop has also resulted in rising private sector/GDP ratios as lower real interest rates have increased the incentive to borrow, and rising asset prices (particularly housing) have improved credit worthiness and the ability to borrow. Debt ratios rise until there is a crash (like what happened in 2008), forcing monetary authorities to lower real rates even further.

-The above process provides a plausible explanation to the current predicament facing the developed world – high asset prices, relatively low levels of real and nominal GDP, and excess debt.

-What are the implications for investors? The critical question is whether the 35 year trend of rising wealth (i.e. falling share of wages in national income) will be reversed anytime soon. If this were to happen, demand and real rates would increase and bring down the growth rate of private debt, leading to a double blow to equities by reducing profits and raising the discount rate.

-What are the reasons behind the falling share of wages in national income? This could have been caused by the increase in supply of unskilled workers (mainly China) into the global workforce, or by technological advances replacing low paid workers, and by the decline of trade unions.

-None of these factors are showing any signs of reversal in the developed world, and it would be difficult to assume that such a strong trend in place over the last 35 years will be reversed in the near future, unless we see a major shift in government policy.

-This could include: 1) a sharp rise in the minimum wage, 2) greater reliance on equity rather than debt in housing and corporate funding could dampen equity returns, and, 3) a shift towards more fiscal spending rather than monetary policy could result in higher rates and reduce inequality. But any of these changes are fraught with difficulty, and if anything, the recent mid-term elections in the U.S. point in the other direction.

-A modest tick-up in wages could cause the Fed to reverse its rate policy and cause a downturn in markets, but it would require a much larger wage increase than we have seen during the last three cycles to suggest that the 35 year trend is in reversal.

A fascinating and thought provoking note, which supports the case for a continued uptrend in asset prices for the foreseeable future – supported by unconventional monetary policy. However, a trend which cannot continue forever will eventually come to an end, causing a serious disruption in markets, but it is unlikely to occur over the course of this decade as long as global QE policies continue. As noted in a previous newsletter, one of the savviest bond investors, Jeffrey Gundlach, argues that we are likely to see QE4 from the Fed sometime in 2018/2019 as the existing bonds in their portfolio mature, forcing the Fed to rollover the bonds rather than selling them into the market which would otherwise cause a serious market disruption.

Under this environment, as stated in previous newsletters, stay cautiously long in a globally diversified portfolio of equities and credit and EM sovereign bonds, lightening-up on strong rallies and adding back on sharp downturns (like we had in early October).

On Why Eat Whole Grains?

There is a view amongst some people that grains are bad for you as they are loaded with crabs, sugar, gluten and cause one to put on weight. But this view is not based on any credible scientific evidence or historical eating habits as pointed out by David Katz, Director of the Yale University Prevention Research Centre:

Huff Post. 11/11/2014

-Whole grains are, and always have been, a mainstay in my diet and the diets of those I love most in the world. Nobody pays me to say that; nobody pays us to eat them! I eat them because I love them; and because the evidence is decisive that they love me back, by promoting my health.

-The odd part of this story is the need to make the case for whole grains in the first place, since they have had the support (as they still do) of the vast majority of nutrition authorities for decades (or maybe forever, since there were whole grains before there were nutrition authorities); have figured prominently in human diets since the literal dawn of civilization; and figure prominently today in the diverse diets of all of the healthiest, longest-lived populations on the planet.

-But this is the age of half-witted nutritional nonsense, including nonsense about whole grains. This is the age of needing to defend what should be self-evident. Not long ago, I did an interview with the New York Times to make the case that, yes, despite the idea that fructose is toxic, it is still okay to eat whole, fresh fruits. Geez! Compared to that, the need to argue that, yes, whole grains really are good for us — almost makes sense.

-But it doesn’t make much sense, and it sure does harm. The more we gyrate in place, re-arguing what we should already know, the less energy is left to do anything with it. If, for instance, despite the evidence that eating fresh fruit can actually defend against diabetes, we invoke arguments about fructose and throw our apples under the bus? We should use what we know – but we seem to have a far greater appetite for questioning reliable answers than answering meaningful questions. I suppose it provides a nice excuse for doing whatever the hell we want.

-And that, I think, is the principal application of the so-called Paleo diet. Actually, I am far from a detractor. I fully endorse the relevance of evolution, natural selection, and adaptation to the dietary needs of all species, our own included. These, of course, are the basis for any argument in support of Paleo eating.

-But after noting that fundamental relevance, things break down quickly. We don’t know exactly what our Stone Age ancestors ate; we can only work out approximations. There were likely variations on the theme of Paleo eating, just as there are variations on the theme of healthful eating today. Our Stone Age ancestors probably ate a fair number of bugs, and nobody seems to want to talk much about that.

-More importantly, the Paleo diet banner is generally flown over diets bearing just about no resemblance to true Stone Age diets, let alone Stone Age lifestyles. There was no Paleolithic bacon, for instance. There was no Paleolithic pastrami, or pepperoni, either. If you want a Stone Age diet, the animals you eat — need to have a Stone Age diet, too. That means venison, antelope, bison, and as a vague approximation, grass-fed cattle. It means game: wild animals of land and sea, living their native lives, and eating their native diets.

-Also routinely ignored is the assertion, that our native intake of fiber was very high — averaging something close to 100 grams per day. The average American gets something like 12 grams. Nobody addressed this better than the famous medical missionary, Denis Burkitt (after whom Burkitt’s lymphoma is named): By global [and historical] standards, the entire population of the U.S. is constipated!

-If Paleo eating really is a good idea, how do you decide which parts of it are important? Is there a basis, for example, to conclude that eating meat is important, but getting that high fiber intake is unimportant? There is not. Pop culture has pulverized the valid concept of Paleo dieting. In my experience, the popularity of the concept resides almost entirely with an appetite for hamburgers and hotdogs, and the pleasant opportunity to pretend there is a halo over those choices.

-No one knows that Paleo eating is best for health. To know for sure, we would need a randomized trial of thousands upon thousands of neonates, assigned to all of the competing dietary patterns, then followed for about 100 years to see which group lives the longest and best on average. I trust you are not surprised to find that study has not been done, nor is it likely any time soon.

-In the interim, though, we do have the real-world evidence of Blue Zone populations about diet, lifestyle, and health across just such a span. As noted, these longest-lived, healthiest populations on the planet all consume whole grains routinely.

-There is evidence that whole grains can be the best solution to the very dietary problems associated with refined grains. In at least one study comparing different ways to achieve a low glycemic load, a mostly plant-based approach including whole grains outperformed a meat-based approach across a wide array of bio-markers.

-The other argument against grains is, of course, the widespread concern about gluten. That concern, however, is far more widespread than actual gluten sensitivity, prevalent though the latter may be. This is an easy one: If you are gluten intolerant, don’t eat gluten. That’s right up there with: If you are allergic to peanuts, don’t eat them. But in neither case does it say anything about what the sensitivity-free majority should do. The food industry has exploited the popularity of gluten-free eating, just as they have exploited every dietary fashion trend before, and the result is abundant new opportunities to indulge in gluten-free junk food.

– If, however, you want to invoke that banner — then go all the way. That means the animals you eat in the name of Stone Age virtues need to have a Stone Age diet themselves. It means something close to 100 grams of fiber daily; many miles of daily walking; no tobacco or alcohol; sleep in accord with the cycles of light; and so on. And by the way, no technology — so stop reading this on a computer!

-Even with all of that, we know nothing about the effects of Paleo living on the full, modern life span — because Stone Age life expectancy was a whole lot shorter.

-The half-baked, half-witted approach to Paleo that prevails is another story altogether. A diet of modern meat from poorly-fed, ill-treated animals conjoined to the exclusion of whole grains that further reduces an already pitiful fiber intake is neither a formula for health, nor even a cogent concept. It has rather dire implications for the fate of the planet as well, since we are no longer scattered, roaming tribes; but a global horde of over 7 billion. It’s not really Paleo; it’s just a convenient excuse for baloney. Excluding whole grains from your diet does not make it Stone Age. Hunting antelope with a spear would be a good start.

-Whole grains have figured prominently in human diets for roughly 15,000 years. They figure prominently in the diets of the healthiest populations alive today. And unlike the mostly extinct choices of our Stone Age ancestors, they are available to us today.